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Sector Allocations: Time to Get Defensive?

October has been a scary month for investors, with steep drops one day followed by sharp rebounds the next. That kind of volatility can make investors nervous. So should investors consider scaling back on stocks?

We don’t think so. The 10-year bull market may still have room to run and we are just entering the end-of-year shopping season—traditionally a positive time for stocks. Historically, the months following midterm elections have also generally been good to the stock market.

That said, investors who want to give their portfolios a more cautious disposition could consider shifting some assets into the more defensive stock sectors.

What are defensive stocks?

Defensive stocks are generally less susceptible to economic downturns because they involve companies that sell products or services that are in demand no matter the economic conditions—like health care, utilities and essential consumer goods such as toothpaste and toilet paper.

“The defensive stock sectors give investors a way to stay in the market and participate, at least to some degree, in any potential upward moves while providing some buffer against a downturn,” says Brad Sorenson, head of market and sector analysis for the Schwab Center for Financial Research. Many defensive stocks also pay dividends, which can provide some comfort, particularly during uncertain times. “Defensive sectors may not necessarily grow during down markets,” adds Brad, “but they have tended to lose less.”

Performance of defensive sectors following downturns

Past performance is no guarantee of future results, of course, but defensive sectors have often outperformed the rest of the market in the months after bull markets have peaked. Brad says that using Ned Davis Research’s definition,1 there have been 13 bull market peaks since 1970, and utilities, consumer staples and health care beat the broader market in the three months after the market peak in almost three-quarters of those cases.Those three sectors, along with real estate, have also historically tended to be less volatile than the overall market.

In addition, the more defensive sectors tend to pay dividends. The utilities and consumer staples sectors are particularly generous, with both sectors paying yields above 3%.2 “And for those concerned about ongoing global trade disputes,” says Brad, “focusing a little more on domestic industries may be appealing. Utilities have no reported foreign sales, and consumer staples derive less than 25% of their sales from foreign sources.”3

Telecom and tech

It may be hard to believe, but the information technology sector could also be worth a second look. This is primarily because of the recent realignment of the sector categories, which saw several higher-volatility tech-related stocks move out of the tech sector and into the new communications services sector.

“After that change, the remaining companies in the tech sector have lower valuations and pay higher dividends,” Brad says. “In other words, the tech sector may look more defensive than it was in its previous iteration.”

Many stocks in the tech sector also have large cash balances, which could mean more share-price-boosting stock buybacks or higher dividend payments down the road. “While it’s quite possible that tech will never become a full-fledged defensive sector, the fact that it has gained some defensive characteristics at least warrants some attention,” Brad says.

Because the bull market could still have space to run in the coming months, Schwab has been suggesting that investors stick with their regular allocations to stocks. But investors who are looking for a more defensive posture could consider shifting some assets into the more defensive parts of the market.

1Ned Davis Research defines a bull market as 30% rise in the Dow Jones Industrial Average after 50 calendar days or a 13% rise after 155 calendar days.

2 Charles Schwab using data from FactSet, as of 9/30/2018.

3Charles Schwab using data from Cornerstone Macro, as of 9/30/2018.

What You Can Do Next

Market volatility is unnerving, but it’s a normal—and normally short-lived—part of investing. If you’ve built a solid financial plan and a well-diversified portfolio, it’s best to ignore the noise and focus on your long-term goals. Want to talk about your portfolio? Call our investment professionals at 800-355-2162.

The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. The investment strategies mentioned here may not be suitable for everyone. Each investor needs to review an investment strategy for his or her own particular situation before making any investment decision.

All expressions of opinion are subject to change without notice in reaction to shifting market conditions. Data contained herein from third-party providers is obtained from what are considered reliable sources. However, its accuracy, completeness or reliability cannot be guaranteed.

Examples provided are for illustrative purposes only and not intended to be reflective of results you can expect to achieve.

Investing involves risk including loss of principal.

Performance may be affected by risks associated with non‐diversification, including investments in specific countries or sectors. Each individual investor should consider these risks carefully before investing in a particular security or strategy.

Past performance is no guarantee of future results.

Diversification does not ensure a profit and do not protect against losses in declining markets.

Indexes are unmanaged, do not incur management fees, costs and expenses, and cannot be invested in directly. For additional information, please see schwab.com/indexdefinitions.

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